The company does not believe the Department of Justice can prove that this failure - common to nearly everyone at the time - was the product of intentional misconduct by anyone at S&P.

It doesn't matter whether it was intentional! The point is, you completely "mis-underestimated" the risk of this junk. It's not so much that the DoJ should punish you, it's that the market (if rational) will completely ignore you from here on and not pay a cent for your worthless ratings.

- common to nearly everyone at the time -

"But Billy and Tommy were doing it too!!!" Jeez, didn't your mother teach you at like age 6 that that excuse doesn't fly??

NOTE: This is not a mere political rant, and it is completely actionable. The actionable point is: When constructing your bond AA, don't even consider S&P's credit ratings.

Depriving ourselves to boost our 40-year success probability much beyond 80% is a fool’s errand, since all you are doing is increasing the probability of failure for [non-financial] reasons. --wbern

They are in the business of selling. What do they do? - they sell opinions, they don't make proclaimations that they know the direction of the market. Those who know the future, would make their money and retire. No need to sell when you are financially set.

Vinny: But your honor, my clients didn't do anything. Judge Haller: Once again, the communication process is broken down. It appears to me that you want to skip the arraignment process, go directly to trial, skip that, and get a dismissal. Well, I'm not about to revamp the entire judicial process just because you find yourself in the unique position of defending clients who say they didn't do it. The next words out of your mouth better be "guilty" or "not guilty." I don't want to hear commentary, argument, or opinion. If I hear anything other than "guilty" or "not guilty", you'll be in contempt. I don't even want to hear you clear your throat. Now, (enunciating) how do your clients plead?

When you discover that you are riding a dead horse, the best strategy is to dismount.

Grt2bOutdoors wrote:They are in the business of selling. What do they do? - they sell opinions, they don't make proclaimations that they know the direction of the market. Those who know the future, would make their money and retire. No need to sell when you are financially set.

Vinny: But your honor, my clients didn't do anything. Judge Haller: Once again, the communication process is broken down. It appears to me that you want to skip the arraignment process, go directly to trial, skip that, and get a dismissal. Well, I'm not about to revamp the entire judicial process just because you find yourself in the unique position of defending clients who say they didn't do it. The next words out of your mouth better be "guilty" or "not guilty." I don't want to hear commentary, argument, or opinion. If I hear anything other than "guilty" or "not guilty", you'll be in contempt. I don't even want to hear you clear your throat. Now, (enunciating) how do your clients plead?

Vinny: But your honor, my clients didn't do anything. Judge Haller: Once again, the communication process is broken down. It appears to me that you want to skip the arraignment process, go directly to trial, skip that, and get a dismissal. Well, I'm not about to revamp the entire judicial process just because you find yourself in the unique position of defending clients who say they didn't do it. The next words out of your mouth better be "guilty" or "not guilty." I don't want to hear commentary, argument, or opinion. If I hear anything other than "guilty" or "not guilty", you'll be in contempt. I don't even want to hear you clear your throat. Now, (enunciating) how do your clients plead?

The Justice Department's Standard & Poors litigation is a civil lawsuit. As a general rule we do "guilty" or "not guilty" pleas in criminal cases, not in civil litigation.

Wow, if their defense is that it wasn't intentional I think they are screwed. In my extremely limited experience with government agencies suing very large corporations, what is contained in the e-mails can be the most damning with respect to intentions. And they've got e-mails.

The company does not believe the Department of Justice can prove that this failure - common to nearly everyone at the time - was the product of intentional misconduct by anyone at S&P.

It doesn't matter whether it was intentional! The point is, you completely "mis-underestimated" the risk of this junk. It's not so much that the DoJ should punish you, it's that the market (if rational) will completely ignore you from here on and not pay a cent for your worthless ratings.

- common to nearly everyone at the time -

"But Billy and Tommy were doing it too!!!" Jeez, didn't your mother teach you at like age 6 that that excuse doesn't fly??

NOTE: This is not a mere political rant, and it is completely actionable. The actionable point is: When constructing your bond AA, don't even consider S&P's credit ratings.

The might all be true, but it's not so simple. I think that the rating industry is very tightly regulated, and the government only lets a few organizations do it. I believe that the relevant term is to be "designated a Nationally Recognized Statistical Rating Organization (NRSRO)":

So even if we all agree that S&P should not be in business because of the errors they recently made, we don't have many alternatives. I don't know what hoops you have to jump thru to get the NSRO designation. But my impression is that if that that market were less regulated then in the aftermath of the credit crisis a bunch of shops would have opened up and no one would have used S&P again because their reputation would have been irreparably damaged.

Presumably the worst thing the government could do to S&P is not fine them, but remove this "NRSRO" designation from them.

Again, I'm not an expert of this. It's just my 2cents on the situation.

I'm pretty close to these guys so I don't want to comment too much... But while they screwed the pooch with structured credit during the crisis their AAA ratings have been accurate (behaved as expected) well over 99% of the time. I forget the exact number, it may even be over 99.9%.

jon-nyc wrote:I'm pretty close to these guys so I don't want to comment too much... But while they screwed the pooch with structured credit during the crisis their AAA ratings have been accurate (behaved as expected) well over 99% of the time. I forget the exact number, it may even be over 99.9%.

If a person messes up in real life, you pay a price. In S&P's instance they still need to pay that price. Your analogy reads like this "Jon is a nice guy 99.5% of the time, one day Jon went to a bar, he was well-aware of the potential outcomes of drinking and then driving, but decided to drive anyway since his friends were more sloshed then he was. Jon hit a group of people crossing when the light was red and severely injured a number of them. But don't forget, it was only one mistake and Jon is a nice guy - sorry, that doesn't fly - there is a fundamental difference between a mistake and consistent irregularities. In auditing, we call the latter - fraudulent reporting. In civil court that is payable in the form of a huge monetary fine. In criminal court of law - prison.

jon-nyc wrote:I'm pretty close to these guys so I don't want to comment too much... But while they screwed the pooch with structured credit during the crisis their AAA ratings have been accurate (behaved as expected) well over 99% of the time. I forget the exact number, it may even be over 99.9%.

If a person messes up in real life, you pay a price. In S&P's instance they still need to pay that price. Your analogy reads like this "Jon is a nice guy 99.5% of the time, one day Jon went to a bar, he was well-aware of the potential outcomes of drinking and then driving, but decided to drive anyway since his friends were more sloshed then he was. Jon hit a group of people crossing when the light was red and severely injured a number of them. But don't forget, it was only one mistake and Jon is a nice guy - sorry, that doesn't fly - there is a fundamental difference between a mistake and consistent irregularities. In auditing, we call the latter - fraudulent reporting. In civil court that is payable in the form of a huge monetary fine. In criminal court of law - prison.

There's a fine line that separates negligence and stupidity. Negligence is actionable, stupidity isn't. The DOJ is arguing S&P was negligent. In its defense S&P will probably play the stupidity card (it can call Ben Bernanke and Allen Greenspan as character witnesses). If you will recall, this defense worked reasonably well for investment bankers who were touting tech stocks (while earning huge underwriting fees) in the late 1990s.

Yes - and the prosecution will call peoples exhibits #1 and #2. The first exhibit will be the e-mail from one credit analyst sending out lyrics of the Talking Heads - Burning Down the House to his fellow credit analyst colleagues who rated these securities and the manager overseeing it. The second exhibit will be the e-mail from another credit analyst proclaiming they would rate "cows" AAA (as in the animal) if the price was right. That's not stupidity, remember these guys/gals were supposed to be the "smartest guys on water street" - smart people aren't stupid, but they can act with negiligence, especially when their compensation package included bonuses and profit-sharing. You don't get either of the last two,unless the unit performs. The primary motivational factor was money.

Going after S&P is absolutely ridiculous. Definitely no law against stupidity. But even further, there is no law against performing badly as a business in the pursuit of profits. We may not like it, but the list is long of others that have done the same. Can easily throw Fannie Mae in there. I'm sure there were emplyees that knew it was all crap, and likely there are e-mails along those lines. But the agencies have criteria that are often published, and it is completely unreasonable to expect an employee with only a partial view of the world to get in front of that train. All of this is so easy in 20-20 hindsight, but we so easily forget how one sided the concensus view was on the world back then.

swaption wrote:Going after S&P is absolutely ridiculous. Definitely no law against stupidity. But even further, there is no law against performing badly as a business in the pursuit of profits. We may not like it, but the list is long of others that have done the same. Can easily throw Fannie Mae in there. I'm sure there were emplyees that knew it was all crap, and likely there are e-mails along those lines. But the agencies have criteria that are often published, and it is completely unreasonable to expect an employee with only a partial view of the world to get in front of that train. All of this is so easy in 20-20 hindsight, but we so easily forget how one sided the concensus view was on the world back then.

Yes, very one-sided. There were people like us saying the market was in a bubble, overheated, credit was being extended to unqualified borrowers. Then you had the folks at S&P saying that credit was being extended to qualified borrowers. Give me a break, already. Since you're in the market you know when thing are overheated and when they are not. We're talking about S&P, not politics - we want to avoid a thread lockdown. The simple solution would be to strip all the ratings agencies of their unofficial licenses as recognized credit agencies - then it would be up to the end-user to decide who is worthy of credit and who is not - when it's your money that's on the line you will be more careful of whom you lend it to.

Much of the discussion here seems to mischaracterize what the DOJ complaint alleges. My (non lawyer) read is that this is entirely about fraud and not at all about negligence. The burden is on DOJ of course, and time will tell whether they actually have the goods to prove fraud and whether that evidence will be made public before a settlement is reached.

But IMO, if the DOJ goes to the mat and proves the claims it makes in the complaint, this could be an existential threat for McGraw-Hill.

The lawsuit alleges that investors, many of them federally insured financial institutions, lost billions of dollars on CDOs for which S&P issued inflated ratings that misrepresented the securities’ true credit risks. The complaint also alleges that S&P falsely represented that its ratings were objective, independent, and uninfluenced by S&P’s relationships with investment banks when, in actuality, S&P’s desire for increased revenue and market share led it to favor the interests of these banks over investors.

According to the complaint, S&P publicly represented that its ratings of RMBS and CDOs were objective, independent and uninfluenced by the potential conflict of interest posed by S&P being selected to rate securities by the investment banks that sold those securities. Contrary to these representations, from 2004 to 2007, the government alleges, S&P was so concerned with the possibility of losing market share and profits that it limited, adjusted and delayed updates to the ratings criteria and analytical models it used to assess the credit risks posed by RMBS and CDOs. According to the complaint, S&P weakened those criteria and models from what S&P’s own analysts believed was necessary to make them more accurate.

The complaint also alleges that, from at least March to October 2007, and because of this same desire to increase market share and profits, S&P issued inflated ratings on hundreds of billions of dollars’ worth of CDOs. At the time, according to the allegations in the complaint, S&P knew that the quality of non-prime RMBS was severely impaired, and that the ratings on those mortgage bonds would not hold. The government alleges that S&P failed to account for this impairment in the CDO ratings it was assigning on a daily basis. As a result, nearly every CDO rated by S&P during this time period failed, causing investors to lose billions of dollars.

magellan wrote:Much of the discussion here seems to mischaracterize what the DOJ complaint alleges. My (non lawyer) read is that this is entirely about fraud and not at all about negligence. The burden is on DOJ of course, and time will tell whether they actually have the goods to prove fraud and whether that evidence will be made public before a settlement is reached.

But IMO, if the DOJ goes to the mat and proves the claims it makes in the complaint, this could be an existential threat for McGraw-Hill.

Jim

You bring up an excellent point, if DOJ does prove it's claim or even if a settlement is made that will lead to a pandora's box of civil lawsuits - where there are pockets, there are vacum cleaners at the ready.

jon-nyc wrote:I'm pretty close to these guys so I don't want to comment too much... But while they screwed the pooch with structured credit during the crisis their AAA ratings have been accurate (behaved as expected) well over 99% of the time. I forget the exact number, it may even be over 99.9%.

If a person messes up in real life, you pay a price. In S&P's instance they still need to pay that price. Your analogy reads like this "Jon is a nice guy 99.5% of the time, one day Jon went to a bar, he was well-aware of the potential outcomes of drinking and then driving, but decided to drive anyway since his friends were more sloshed then he was. Jon hit a group of people crossing when the light was red and severely injured a number of them. But don't forget, it was only one mistake and Jon is a nice guy - sorry, that doesn't fly - there is a fundamental difference between a mistake and consistent irregularities. In auditing, we call the latter - fraudulent reporting. In civil court that is payable in the form of a huge monetary fine. In criminal court of law - prison.

You misinterpreted my post - I made no argument against them paying any price for fraud, if they did in fact commit fraud. I was specifically addressing the comment that today's S&P ratings are worthless. They aren't.

jon-nyc wrote:But while they screwed the pooch with structured credit during the crisis their AAA ratings have been accurate (behaved as expected) well over 99% of the time. I forget the exact number, it may even be over 99.9%.

Billions of dollars of CDOs that S&P rated AAA failed. Their AAA ratings don't seem to be very reliable. Why would you trust them?

jon-nyc wrote:I made no argument against them paying any price for fraud, if they did in fact commit fraud. I was specifically addressing the comment that today's S&P ratings are worthless. They aren't.

If in fact S&P committed fraud and provided worthless ratings in the past, how can you be certain they aren't doing it now or will again in the future?

jon-nyc wrote:I made no argument against them paying any price for fraud, if they did in fact commit fraud. I was specifically addressing the comment that today's S&P ratings are worthless. They aren't.

If in fact S&P committed fraud and provided worthless ratings in the past, how can you be certain they aren't doing it now or will again in the future?

I can't be certain that they're not worthless, but that doesn't mean that they are.

On a separate note, why are people so eager to let the investors off the hook for not knowing what they were investing in? Had they relied upon the rantings and disclaimers of the homeless bums that lived on their front stoop, would the DOJ now be combing through shelters?

I mean seriously, if you're an investor getting free ratings from S&P, do you think McGraw-Hill is just doing charity work for you - perhaps part of their Bonuses for Underperfoming PE Managers program?

jon-nyc wrote:I made no argument against them paying any price for fraud, if they did in fact commit fraud. I was specifically addressing the comment that today's S&P ratings are worthless. They aren't.

If in fact S&P committed fraud and provided worthless ratings in the past, how can you be certain they aren't doing it now or will again in the future?

I can't be certain that they're not worthless, but that doesn't mean that they are.

On a separate note, why are people so eager to let the investors off the hook for not knowing what they were investing in? Had they relied upon the rantings and disclaimers of the homeless bums that lived on their front stoop, would the DOJ now be combing through shelters?

I mean seriously, if you're an investor getting free ratings from S&P, do you think McGraw-Hill is just doing charity work for you - perhaps part of their Bonuses for Underperfoming PE Managers program?

Read between the lines - investors if you will, were buying packaged MBS securities, yes. The ultimate end-user (the home purchaser) had no idea that an oligopoly was instrumental in causing an overheated marketplace by assigning worthless valuations that led to severe overpayment of assets financed by leverage. Is S&P on the hook for the leverage?, why no - Joe Pop and Ms. Sally are! There isn't a fine big enough to make fair restitution to those who are either underwater, have unrealized losses, etc.

The company does not believe the Department of Justice can prove that this failure - common to nearly everyone at the time - was the product of intentional misconduct by anyone at S&P.

It doesn't matter whether it was intentional!

Legally, it does matter. If they were intentionally skewing the results of their credit model to make issuers happy, then they violated their fiduciary duty and can be sued by investors and possibly held criminally responsible. If they were merely incompetent, then there's no recourse. Things get a little unclear if you claim they were negligent or grossly negligent...

NOTE: This is not a mere political rant, and it is completely actionable. The actionable point is: When constructing your bond AA, don't even consider S&P's credit ratings.

Well, their opinion is free to you and has *some* informational value, so you shouldn't totally ignore it if you are buying individual bonds. (Though why someone on this forum would do that instead of investing in a credit bond fund is unclear to me.) But you should also take account of the implied credit rating from the prices of credit default swaps as well as other information that's available to you.

jon-nyc wrote:I'm pretty close to these guys so I don't want to comment too much... But while they screwed the pooch with structured credit during the crisis their AAA ratings have been accurate (behaved as expected) well over 99% of the time. I forget the exact number, it may even be over 99.9%.

If a person messes up in real life, you pay a price. In S&P's instance they still need to pay that price. Your analogy reads like this "Jon is a nice guy 99.5% of the time, one day Jon went to a bar, he was well-aware of the potential outcomes of drinking and then driving, but decided to drive anyway since his friends were more sloshed then he was. Jon hit a group of people crossing when the light was red and severely injured a number of them. But don't forget, it was only one mistake and Jon is a nice guy - sorry, that doesn't fly - there is a fundamental difference between a mistake and consistent irregularities. In auditing, we call the latter - fraudulent reporting. In civil court that is payable in the form of a huge monetary fine. In criminal court of law - prison.

Fundamentally you are paying the credit rating agency for a forecast. And forecasts have inherent error because people can't predict the future with certainty. So your analogy doesn't work.

In this case, they got precisely one forecast wrong, (The correlation on mortgage default risk during a financial crisis.) and even here, as a % of their ratings, I'm not sure how much it moves the data if you look at default rates over a long period of time and compare that data with and without these securities.

In any event, these securities are complicated instruments and while everyone wants to say that the risks were obvious, that's only true in hindsight. Very few people were making correct criticisms in real time.

Grt2bOutdoors wrote:Read between the lines - investors if you will, were buying packaged MBS securities, yes. The ultimate end-user (the home purchaser) had no idea that an oligopoly was instrumental in causing an overheated marketplace by assigning worthless valuations that led to severe overpayment of assets financed by leverage. Is S&P on the hook for the leverage?, why no - Joe Pop and Ms. Sally are! There isn't a fine big enough to make fair restitution to those who are either underwater, have unrealized losses, etc.

I may be misunderstanding you, but just to be clear, home purchasers are not in any way the "end-user" of an MBS - investment managers and their investors are. Home purchasers were also not required to leverage up to finance their homes on the onerous terms too many signed up for.

Grt2bOutdoors wrote:Read between the lines - investors if you will, were buying packaged MBS securities, yes. The ultimate end-user (the home purchaser) had no idea that an oligopoly was instrumental in causing an overheated marketplace by assigning worthless valuations that led to severe overpayment of assets financed by leverage. Is S&P on the hook for the leverage?, why no - Joe Pop and Ms. Sally are! There isn't a fine big enough to make fair restitution to those who are either underwater, have unrealized losses, etc.

I may be misunderstanding you, but just to be clear, home purchasers are not in any way the "end-user" of an MBS - investment managers and their investors are. Home purchasers were also not required to leverage up to finance their homes on the onerous terms too many signed up for.

Just to be clear - an MBS tranche is a financing mechanism by the lenders used to offload loans (risk) to third-parties. If the MBS mechanism was not available, the amount of lending capacity would drop precipitously as the banks would have to hold capital on their books in reserve. In other words, in the old days, banks would lend directly to home purchasers and keep the risk on their books. Today, the banks are merely conduits but the actual financier of those loans are the investors in MBS and there are built in fees in the mortgage that pay for the servicing of mortgages held in an MBS or at the bank. The incorrect valuation of the MBS led to wild overvaluations of properties - in essence, the AAA rating given was of such comfort to investors that they were essentially and mistakenly led to believe that you could not "lose" with real estate. A flood or tsunami of capital was available for MBS purchases - that flood needed a "home" - if you could breathe you could qualify based on the premise the underlying real estate could not lose value. A feeding frenzy developed - and there were many who lost. Today, given the resultant outcome of the mis-valuation - that tsunami of capital is no longer available - stricter underwritings, longer times to close deals, repeated evaluations of properties, properties sit for longer periods of time before either being taken off the market or having sold.Sometimes, being in the 18th century might not be a bad thing at all, the punishments were harsher and finality was certain. Five years later, and not much has been fixed.

The individual investor shouldn't be let off the hook. This IMO was a widespread failure of personal ethics. Worst of all perhaps were the individual borrowers who LIED on stated-income mortgage apps and then wanted to claim afterward that they were hoodwinked because the "lender" (Fannie/Freddie front-end) told them it was OK to lie.

I knew someone would call hindsight bias, so let me briefly describe what I remember from that period. I was shopping for a house ca. 2003 and noticed that prices were already up ~20% from just 3 years earlier. Then I read about the MBS/CDO deregulation, repackaging of "diversity loans," etc., and was telling everyone who would listen to sell their houses. I remember considering buying long-term puts on FNM that would have expired in 2005. (Good thing I didn't!) Then I started seeing the "Fire your landlord!" and "Own for less than renting!" billboards (2004-5). Then (2006-7) some of my friends were telling me what an idiot I was for working and saving, when they'd made $50-100K on their houses in one year. I had two co-workers who quit their day jobs to "get into real estate." I knew an appraiser (who can barely fog a mirror) who was making well over $100K, and she told me of the daily faxes that said, "Must appraise for $_____" (which is illegal). By then (2007) there were mainstream news articles about the neg-am ARMs, the "liar's loans," bus drivers buying mansions, etc. Still the MBSs were rated like Treasuries. Everyone knew exactly what they were doing.

This is another chapter for Chancellor's Devil Take the Hindmost, with the credit rating agencies as willing cheerleaders. Who cares if they're honest 99% of the time? The ethical measure of a man is what he does in that tempting 1% case.

Depriving ourselves to boost our 40-year success probability much beyond 80% is a fool’s errand, since all you are doing is increasing the probability of failure for [non-financial] reasons. --wbern

This is also in a sense a page out of Taleb's books. By collectivizing all the little bad risks (with an implied bailout), they created an existential risk to the whole system and widespread moral hazard. So fine, I concede that their ratings of individual munis or whatever are probably not bad.

Depriving ourselves to boost our 40-year success probability much beyond 80% is a fool’s errand, since all you are doing is increasing the probability of failure for [non-financial] reasons. --wbern

Grt2bOutdoors wrote:Just to be clear - an MBS tranche is a financing mechanism by the lenders used to offload loans (risk) to third-parties. If the MBS mechanism was not available, the amount of lending capacity would drop precipitously as the banks would have to hold capital on their books in reserve. In other words, in the old days, banks would lend directly to home purchasers and keep the risk on their books. Today, the banks are merely conduits but the actual financier of those loans are the investors in MBS and there are built in fees in the mortgage that pay for the servicing of mortgages held in an MBS or at the bank. The incorrect valuation of the MBS led to wild overvaluations of properties - in essence, the AAA rating given was of such comfort to investors that they were essentially and mistakenly led to believe that you could not "lose" with real estate. A flood or tsunami of capital was available for MBS purchases - that flood needed a "home" - if you could breathe you could qualify based on the premise the underlying real estate could not lose value. A feeding frenzy developed - and there were many who lost. Today, given the resultant outcome of the mis-valuation - that tsunami of capital is no longer available - stricter underwritings, longer times to close deals, repeated evaluations of properties, properties sit for longer periods of time before either being taken off the market or having sold.Sometimes, being in the 18th century might not be a bad thing at all, the punishments were harsher and finality was certain. Five years later, and not much has been fixed.

All true, but does not explain why the breathing borrowed so much money, and now expect to be held blameless.

For example, it's still exceptionally easy to borrow money for law school - there's a flood of money "needing" a home you might say - yet law school applications are at 30-year lows.

In any case, we're quite far off the topic of the lawsuit. The DOJ is suing S&P for fraud, saying they claimed to rate impartially but did not in practice. Maybe they're right, but my main point is that still doesn't excuse the abject incompetence of the investment managers who relied exclusively on S&P's ratings instead of doing their own due diligence or choosing not to invest. Presumably because it would be politically unpopular to revoke them, these managers still have their securities licenses and can continue to fail and play the blame game.